How To Calculate Bond Accrued Interest And Understand Business Credit Basics

Bond Issuance and Valuation by Mirvac Ltd.

Mirvac Ltd., an Australia based Company, engaged in the business of Real Estate. It is the real estate owner and developers. It operates throughout the Australia. It engaged in the various operations like property development, hotels, property construction, assets management etc. It has developed the commercial spaces and residential buildings for its customers (CBONDS, no date). Its major focus is to capture urban environment with the use of latest technologies and providing upgraded amenities in its projects. It has contributed a good proportion in Australian economy because it had a major focus on its service and potential up gradation in its service. (Mirvac, no date)

Mirvac Ltd. has issued the bond to raise the funds. The debt portion of the company is majorly covered by the bonds i.e. as at 30 June 2017, the bonds covers 74% of the total debt sources of the company. The type of bond issued by the company is “Coupon Bonds”. The placement method is “Open Subscription”. The detail of the bond issued by the company is as under (Bloomberg, no date):

1. Type of the securities: Senior Bond
2. Maturity Date: 18September 2020
3. Coupon Rate and Frequency: 5.75 percent and 2 times per year
4. Par Value: $ 100
5. Credit Rating: A3
6. Coupon Type: Fixed

In this section, we will discuss about the full price, clean price and accrued interest on the bond issued by the company.

1. Accrued Interest:  This refers to the amount which has not actually been paid but accrued and it is to be paid o due date. In other words, it is the amount of interest accrued between the last due date of interest and present date. (Lioudis, 2018)

In the present scenario, it will be calculated as following:

A = P * C/F * D/T

A (Accrued Interest)

P (Par Value of the Bond) = $ 100

C (Annual Coupon Rate) = 5.750%

F (Frequency) = Semi-annual (2 times in a year)

D (Days) = 163 (19 March 2018 to 28 August 2018)

T (Total number of days in payment period) = 180 Days

A = 100*0.05750/2 * 163/180

A = $ 2.60

1. Full Price: It refers to the present value of future cash flows. It is the price which the investor pays to acquire the bond. It is the price quoted in the market. In the present case Full Price of the bond has been taken from market, which is as follows:

Full Price: $ 109.03

• Clean Price: It refers to the price of bond excluding accrued interest. It is the discounted cash flow and does not include the accrued interest. It can be calculated as follows:

Clean Price = Full Price – Accrued Interest

Clean Price = 109.03 – 2.60

Clean Price = $ 106.43

It is the risk of changes in the interest rates due to which there may be chances of increase or decrease in market price of the bond. It may suffer the investor’s decisions for the investment in a particular bond (Lenaghan, 2017). There are some factors to analyze the interest rate risk:

1. Macaulay Duration: It is the measure of changes in bond prices due to changes in the interest rates. It is calculated as follows:

Macaulay Duration = PV1/PV * T1 + PV2/PV * T2 + ……..+ PVn/PV * Tn

PV1, PV2 ….PVn = Present value of cash flows

T1, T2 …..Tn = Number of Years

PV = Price of the Bond

Yield = 2.507% (XTB, no date)

Coupon Rate = 5.75 Annual (2.875 semi-annual)

Semi-year	1	2	3	4	5	6	7	8	9	10	11	12	13	14
Coupon Amount	2.875	2.875	2.875	2.875	2.875	2.875	2.875	2.875	2.875	2.875	2.875	2.875	2.875	2.875
Maturity Value	–	–	–	–	–	–	–	–	–	–	–	–	–	100
Total Cash Flow	2.875	2.875	2.875	2.875	2.875	2.875	2.875	2.875	2.875	2.875	2.875	2.875	2.875	102.875
PV Factor	.975	.952	.928	.906	.884	.862	.841	..821	.800	.781	.762	.743	.725	.707
PV @ 2.507%	2.803	2.737	2.668	2.605	2.542	2.478	2.418	2.360	2.300	2.245	2.191	2.136	2.084	72.733
Proportion (PV/Price)	2.803	2.737	2.668	2.605	2.542	2.478	2.418	2.360	2.300	2.245	2.191	2.136	2.084	72.733
Time Factor	1	2	3	4	5	6	7	8	9	10	11	12	13	14
Duration	2.803	5.474	8.004	10.419	12.708	14.870	16.925	18.883	20.700	22.454	24.098	25.634	27.097	1018.257

Interest Rate Risk Analysis

Macaulay Duration: 12.28

1. Modified Duration: It is the adjusted version of Macaulay Duration, which is accounted for every change in the Yield to Maturity. This can be calculated with the help of Macaulay Duration, Yield to Maturity and Coupon Periods. Difference between Macaulay Duration and Modified Duration presents increase in duration for every percentage change in Yield to Maturity (YTM) (Fidelity, no date).

For Example:

Macaulay Duration of the bond = 5.82 years

Modified Duration of the bond = 5.32 years

If YTM increases by 1 percent then bond duration will be decreased by 0.50 years (5.82 – 5.32 years).

Modified Duration of the bond can be calculated with the help of following formula:

Value of the Macaulay Duration/ (1 + Yield to Maturity) / Number of Coupon period per year

In the present case Modified Duration is as follows:

= 12.28/ (1 + 0.02507) / 1

= 12.28/1.02507

= 11.98 Years   

If there is 1 percent increase in the Yield to Maturity, then there will be a decrease in duration of bond is as follows:

Decrease in duration of bond = 12.28 – 11.98

Decrease in duration of bond = 0.3 years

Convexity: Convexity describes the relationship between the price of bond and its yield (Financial Pipeline, no date).It represents that there is no linear relationship between the bond’s price and bond’s yield. If there is an increase in the interest rate the bond price will get reduced or vice-versa. (XPLAIND, no date)

P denotes price of the bond = $ 109.03

Y denotes the Bond’s Yield = 2.507%

Annual Convexity = Semi-annual convexity/4

      = 63.55/4

Annual Convexity = 15.89

Bonds Modified Duration due to change in interest rate by 10bp

Price change = (-duration * change in yield * 100) +(Convexity * change in yield squared * 100)

= (-11.98 * 0.010*100) + (15.89 * 0.010 squared * 100)

= (-11.98) + (0.1589)

= 11.82

If rates shocked by 10bps, the price of bonds will decreased by 11.82%

Approximate Convexity:

Change in price for 10bps shocked in yield

Change in price = – Modified duration * Change in Yield

= -11.82*0.010

= -11.82%

So the price would decrease by 12.89 (109.03 * 11.82%)

Duration and Interest rate Risk: The term duration determine the sensitivity of the bond price. Bond prices are changed with the changes in the interest rates. In technical term, duration of bond can be considered as measurement of the interest rate risk. There is an inverse relation between bond price and interest rate. When interest rate is increased then bond price will get reduced and if interest rate is decreased then bond price will increase.

Duration of bond is measured in number of years. The rule of thumb is that, every 1 percent increase or decrease in the interest rates, the bond’s price will be changed adversely for every year of duration. More the duration means investor has to wait long time to receive the coupon payment and principal amount.

Duration and Interest Rate Risk

For Example:

A bond has 6 year duration. If there is an increase in interest rate by 1 percent, then bond’s price will get reduced by 6 percent or vice versa.

Capacity Discussion: In this we analyze the ability of the company to pay its dues. It can be measured through the cash flow statement. A business can be considered as sound enough if recovery from account receivables is being made within the stipulated time. On the other hand, if the payment of dues is being made within the time, then it represents the better capacity of the company.

In the present case, cash flow statement is showing the better position of Mirvac Ltd., as cash inflow and outflow are frequent during the year. At the year-end it has positive cash and cash equivalent, which represent the recovery of account receivables was regular.

In addition to that, the company has made borrowing from bank loans and by issuing bonds i.e. it has made the unsecured borrowings rather than secured borrowings. If a company is going for unsecured borrowing, it means that the company is not carrying on the business activities smoothly. The debt structure of the company is not good as it borrowed a huge amount from unsecured sources rather than secured sources.   

1. EBITDA Ratio
Particulars	2017	2016	2015	2014	2013
Mirvac Group
EBITDA	1,300.00	1,249.00	803.40	635.10	233.20
REVENUE	3,021.00	3,052.00	1,695.60	1,868.00	1,469.70
EBITDA Ratio [(EBITDA/REVENUE ]	0.43	0.41	0.47	0.34	0.16

EBITDA of the company is constantly increasing except only there is a decrease in the year 2016 as compared to the year 2015. The reason for decrease as non-operating revenue of the company is higher as compared to previous year.

2. Return on Capital
Particulars	2017	2016	2015	2014	2013
Mirvac Group
Net profit after dividend	1,163.00	1,073.00	627.10	446.40	162.50
Total Capital (Equity)	7,972.00	7,180.00	6,462.10	6,176.10	6,010.80
Return on Capital	0.15	0.15	0.10	0.07	0.03

Return on capital increased by 0.05 in the year 2016 as compared to year 2015. Reason for the same is that there was a high increment in net profit after dividend which shows the growth of the company.

3. EBIT INTEREST COVERAGE
Particulars	2017	2016	2015	2014	2013
Mirvac Group
EBIT	1,266.00	1,212.00	773.00	605.50	201.90
INTEREST	162.00	137.00	145.10	144.80	87.10
EBIT INTEREST COVERAGE	7.81	8.85	5.33	4.18	2.32

This ratio presents how much time the interest is covered by the profit. In the year 2016 finance cost decreased due to repayment of debt and profit has been increased correspondingly.

4. EBITDA INTEREST COVERAGE
Particulars	2017	2016	2015	2014	2013
Mirvac Group
EBITDA	1,300.00	1,249.00	803.40	635.10	233.20
INTEREST	162.00	137.00	145.10	144.80	87.10
EBITDA INTEREST COVERAGE	8.02	9.12	5.54	4.39	2.68

This ratio presents, how much time interest is covered by EBITDA. Ratio in the year 2016 has been increased as depreciation and amortization has not been considered.

5. FFO/DEBT
Particulars	2017	2016	2015	2014	2013
Mirvac Group
FFO (FUND FROM OPERATIONS)	513.00	509.00	412.70	399.30	385.90
DEBT	2,965.00	2,815.00	2,633.90	2,717.60	2,167.20
FFO/DEBT	0.17	0.18	0.16	0.15	0.18

 

This ratio represents the company’s ability to pay-off its debt using net operating income. In all the years it was approximately constant due to no major changes are there in cash flow from operating income.

6. Free Cash Flow after Dividend/Debt
Particulars	2017	2016	2015	2014	2013
Mirvac Group
Free Cash Flow After Dividend	139.00	154.00	76.50	119.10	160.00
Debt	2,965.00	2,815.00	2,633.90	2,717.60	2,167.20
Free Cash Flow after Dividend/Debt	4.69	5.47	2.90	4.38	7.38

This ratio refers to the how much time debts are covered by the free cash flow after dividend. In the year 2017 this ratio is 4.69 times as compared to the year 2015. Reason for the same is free cash after dividend has been increased to double in the year 2017 as compared to the year 2015.

7. Debt/EBITDA
Particulars	2017	2016	2015	2014	2013
Mirvac Group
Debt	2,965.00	2,815.00	2,633.90	2,717.60	2,167.20
EBITDA	1,300.00	1,249.00	803.40	635.10	233.20
DEBT/EBITDA	2.28	2.25	3.28	4.28	9.29

4 C’s Credit Analysis

This ratio refers to the how much proportion of debt is covered by the EBITDA. In the year 2017 the ratio is 2.28 this shows the better position of the company to cover the debt.

Character Discussion: In this we discuss the some factor of the business to analyze the character of the company such as structure of business, history, size, location etc. Some of the factors to be discussed are as follows:

Corporate Governance: It is the set of rules, policies or standards, which is to be followed by an organization to protect the interest of its stakeholders like shareholders, financiers, government, customers etc. Mirvac Ltd. has made the system, procedures, rules and practices, which ensures the corporate governance in the company. The company’s corporate governance framework is consistent with the Corporate Governance Principles issued by the ASX Corporate Governance Council.

1. Soundness of Management Strategy:Management strategy will be considered as sound when it maximizes the return on investment of stakeholders. Mirvac Ltd. focused on the deployment of capital in its promised projects. It has also focused on urban market and tried to become an expert in the market in which it operates. Management of the company has come up with one more strategy which is ‘maximize the value of the assets’. For this strategy it has develop assets management system that would ensure the increase in value of assets by providing high-quality services.
2. Management Track Record: It also plays a vital role in character discussion of any enterprises. Mirvac Ltd. has the biggest risk of settlement. It has prepared the strategy to monitor the settlement risk. It has decided to get in touch with its customers until project is completed. By this strategy, the management proved the track record of managing the settlement risk as it has controlled the defaults.
3. Aggressive Accounting/Tax Strategies: It refers to the accounting practices which are designed to overstating the financial performance manipulating the actual data. Mirvac Ltd. did not followed such type of accounting practices as its actual financial performance is better than other companies in the same industry. It has also not made any default in payment of tax. (Hanks, no date)
4. History of Fraud/Malfeasance:Any fraud committed by any organization, spoils its reputation and that would result in a downfall in market share. In the present case, Mirvac Ltd. has not committed any fraud in past years. Its growth in the past years ensures the companies quality services.
5. Treatment of the bond holders:The Company has tried to increase in value of the bond. It has taken into consideration the interest risk analysis to reduce the impact of variation in interest risk to the bond price (adverse impact).               

Collateral: The term ‘liquidation’ refers to the end of business and to distribute the assets among the claimants. Assets are distributed on the basis of priority of the claimants. The secured creditors are given priority over the other creditors. If secured creditors has collateral over their loan to company they can seize the collateral and sell it for distribution of proceeds from such sale. But, on the other side, company’s assets should be valuable. If it has no value then what the secured creditors would get. In the instant case, Mirvac Ltd. has considered the credit risk i.e. the risk of non-payment by the counterparty even if they become due. Such credit risk may be concerned with cash and cash equivalent, receivables, other financial assets etc. The company has managed such credit risk by setting a credit limit and obtained the collateral as security. The company has collateral over accounts receivables of $ 219m (2017). As such, assets are secured and which would not create any hurdle at the time of liquidation.

Covenants of Bonds: It refers to the agreement based on term and conditions between bond issuer and bond holders. These are designed to protect the interest of both in the issue of bond. When an issuer of the bond violates the covenants of the bonds, he is penalized for such default. The penalty is imposed in term of decrease in rating of bond.

Moody’s has a rating scale of 1 to 5 for bond’s covenants. If, it is 5 that means, issuer violating the bond covenants constantly.

Conclusion:

As we discussed above, the company is most concerned about its issued bonds. It has all the safeguards for its bonds such as collateral to its assets, sound strategic decisions, good corporate governance etc. We can conclude that the bond price will be upgraded as the company has also considered the interest risk analysis. 

References:

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